2017-0732681E5 Payment of pension surplus to US resident beneficiary

Principal Issues: Is a payment to a U.S. resident beneficiary of the funds remaining in an Individual Pension Plan on plan wind-up considered to be a periodic pension payment for the purpose of the reduced withholding tax rate in subparagraph 2(b) of Article XVIII of the Canada-U.S. Tax Convention?

Position: No.

Reasons: The payment is a lump sum distribution of surplus.

Author: Podor, Karina
Section: 212(1)(h); definition “periodic pension payment” in section 5 of the ITCIA; Article XVIII of Canada-U.S. Tax Convention

                                                                                         2017-073268
XXXXXXXXXX                                                                  K. Podor

September 12, 2019

Dear XXXXXXXXXX:

Re:   Payment of pension surplus to U.S. resident beneficiary

This is in reply to your correspondence of November 16, 2017 in which you requested our views as to whether a payment to a U.S. resident beneficiary of the funds remaining in an Individual Pension Plan (“IPP”) on the wind-up of the plan is considered to be a periodic pension payment for the purpose of Article XVIII of the Canada-U.S. Tax Convention (the “Treaty”). We apologize for the delay in our reply.

You have asked us to comment on the following hypothetical situation:

*    Ms. X is the sole member of an IPP set up for her benefit. Upon retirement, Ms. X began receiving lifetime retirement benefits (“LRBs”) payable on a monthly basis from the IPP, subject to a 10-year guarantee. 

*    Ms. X dies during the guarantee period. In accordance with the terms of the IPP and the beneficiary designation, the monthly benefits payable for the remainder of the guarantee period will be made to Ms. X’s daughter, who is a U.S. resident.

*    At the end of the guarantee period once all benefit obligations of the IPP have been satisfied, the IPP will be wound up and the remaining funds in the IPP will be distributed to the daughter.

Our comments

This technical interpretation provides general comments about the provisions of the Income Tax Act (the “Act”) and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R9, Advance Income Tax Rulings and Technical Interpretations.

Under paragraph 212(1)(h) of the Act, a withholding tax rate of 25% applies to a payment of pension benefits to a non-resident, subject to certain narrow exceptions that are not relevant to your query. Subparagraph 2(a) of Article XVIII of the Treaty limits the withholding tax rate to 15% for periodic pension payments. The term “periodic pension payment” is not defined in the Treaty, but section 5 of the Income Tax Conventions Interpretation Act defines the term for the purposes of Canada’s income tax treaties. The definition expressly excludes a lump sum payment, or a payment that can reasonably be considered to be an instalment of a lump sum amount, under a registered pension plan (“RPP”).

You have suggested that the final distribution payment to the daughter is simply an extension of the periodic guarantee payments that the daughter was receiving and thus should be eligible for the reduced withholding tax rate under the Treaty. We disagree with this conclusion. In our view, the guarantee payments and the final distribution payment are separate and distinct payments. The guarantee payments are periodic benefits payable under the terms of the IPP, which the employer was generally entitled to fund and which are permissible benefits pursuant to paragraph 8503(2)(c) of the Income Tax Regulations (the “Regulations”). In contrast, the final distribution payment is a lump sum payment of an actuarial surplus that relates to the IPP, which is a permissible distribution pursuant to subparagraph 8502(d)(vi) of the Regulations. Accordingly, the 15% withholding tax rate under the Treaty does not apply to the final distribution payment.

While not raised in your query, we would like to comment on two additional scenarios. It is our view that any additional payment that an IPP may be required to make in a particular year to comply with the IPP minimum amount rules in subsection 8503(26) of the Regulations is not considered to be a periodic pension payment. Depending on whether the payment is made in a single amount or in instalments over the course of the year with the member’s LRBs, such a payment would either be a lump sum payment or an instalment of a lump sum amount. It is separate and distinct from the series of periodic payments that comprise the member’s LRBs. Whether an IPP must make such a payment has to be determined each and every year by reference to the current value of the IPP’s assets and an age-based factor. Therefore, any such payment made to a non-resident is subject to the full 25% withholding tax rate under paragraph 212(1)(h) of the Act.

Similarly, a commutation payment made to a member or a beneficiary of a member in full or partial satisfaction of their entitlement to benefits under a defined benefit RPP is not a periodic pension payment. For example, if the daughter had elected to commute her guarantee benefits, the lump sum payment would have been subject to the 25% withholding tax rate. 

We trust these comments will be of assistance.

Yours truly,

Dave Wurtele
Section Manager
for Division Director
Financial Industries and Trusts Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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